1 Econ 102 Spring 2010 Regulation: Anti-Competitive Behavior

2 Government Regulation Major categories –Anti-competitive behavior Price Discrimination Collusion Mergers/acquisitions –Natural Monopolies –Externalities Pollution Fishing, forestry, mining, oil drilling

3 Government Regulation Tools available –Statutory Prohibitive –E.g. Price fixing/restricting output, cartels, collusive behavior Fines, breakup (divestiture) –Deregulation Removing regulation –Airlines, Banking Incentive mechanisms –Managed competition –Incentive design

4 Promoting Efficiency Goals of regulation –Promote Technological Innovation –Efficiency in Production –Efficiency in Allocation

5 Efficiency in Production Produce Goods at Least Cost –Firms to operate at the minimum of their Long Run Average Cost Curve

6 Efficiency in Allocation Marginal value consumers place on last (marginal unit) produced to equal the resource “opportunity” costs –MV = MC at the marginal unit

7 Government Regulatory Agencies Administrative Agencies Federal Trade Commission (1914) Act –“empowered to pursue abuses of trade that could lessen competition” Department of Justice (DOJ) –Jointly charged with FTC for overseeing and enforcing antitrust policy –Established by the Judiciary Act of 1789 –1870 Act: handle the legal business of the United States. –control over all criminal prosecutions and civil suits in which the United States had an interest Federal Communications Commission (FCC) –established by the Communications Act of 1934Communications Act of 1934 –charged with regulating all non-Federal Government use of the radio spectrum (including radio and television broadcasting), and all interstate telecommunications (wire, satellite and cable) as well as all international communications that originate or terminate in the United States.regulating spectrumradiotelevision telecommunicationswiresatellitecable communications

8 What Happens in Different Markets? Monopoly/Oligopoly –Single-price monopolist/cartel (collusive) –Price Discrimination Block pricing – 2 nd degree Third degree: different prices for different WTP –Income, sex, age, geography Monopolistic Competition –“branding” for market power advertising –Geographic pricing, e.g., Madison Park shell, CD grocery stores –Price points and product proliferation Perfect Competition –Compete by reducing costs

9 Perfect Competition Standard of comparison for all market models (optimal) –Productive efficient Firms operate at min of LRAC or exit –Technological innovate Innovate or die –Allocative efficient Consumers value marginal unit at MV –Equals firm’s cost of producing marginal unit No deadweight loss

10 Monopoly Not Efficient in Production –Never operate at min of LRAC –Underutilized capacity and resources Not Technologically Innovative –No incentive to invest in/develop new technology when you’re the only firm Not Efficient in Allocation –P (=MV) > MR = MC –Deadweight loss

11 Monopolistic Competition Not Efficient in Production –Never operate at min of LRAC –Underutilized capacity and resources Technologically Innovative –Competition with other firms provides incentive Not Efficient in Allocation –P (=MV) > MR = MC –Deadweight loss (but not as great as Monopoly)

12 How Has the Government Sought to Regulate Markets? Punishing Anti-Competitive Behavior –Pricing/market tactics Collusion –Price-fixing, restricting output Price Discrimination Predatory Pricing –Impose fines for AC tactics Preventing Anti-competitive Behavior –Mergers and Acquisitions Review by appropriate administrative agency –Divestiture/breakups Regulating Natural Monopolies Deregulation(sic) of Selected Industries

13 Antitrust and Regulation Antitrust Laws –Sherman Antitrust Act(1890) Trusts are combinations of firms organized to restrain price competition (“Robber-Baron” Law) Outlaws: –Agreements to fix prices (price collusion) –Monopolies and attempts to monopolize »Mergers and acquisition review »Airlines and media mergers

14 Antitrust and Regulation Antitrust Laws –Clayton Antitrust Act (1914) Forbids mergers if they lessen competition Prohibits tie-in sales –Robinson-Patman(1936) 3 rd degree price discrimination (different prices for different markets) Amendment to Clayton Act –Federal Trade Commission Act (1914) “enabling” legislation – establishes FTC and gives them authority to initiate and decide cases involving “unfair” competition, deceptive practices and unfair methods of competition

15 Antitrust and Regulation Regulation –Federal Communications Act (1930) Establishes/enables FCC to regulate communications companies Initially focused on telecommunications Extended lately to media (newspapers, television, radio and internet/broadband) –Federal Aviation Authority (FAA) Initially empowered to determine routes, rates and carriers, establish safety guidelines Partially “deregulated” in the 1980’s, except for safety

16 Punishing AC Behavior Punishing firms for behaving like a monopoly –Sherman anti-trust Act (1890) “conspiring to fix prices or restrict output” –Clayton Act (1914) More sophisticated price discrimination Tie-in sales – requiring the purchase of 2 nd good Stock purchases/acquisitions –Robinson-Patman(1936) 3 rd degree price discrimination Amendment to Clayton Act

17 Reviewing Mergers Primarily aimed at preventing mergers or acquisitions that reduce competition –FCC regulates communications media (newspapers, tv, telecomm, radio) –FTC and DOJ regulate the rest

18 Where We’re Going How do we tell if a merger is anti-competitive? –Market Concentration CR4: market share for the 4 largest firms Herfindahl Index (HHI): computed from the squares of the market shares Strategic behavior (how do they behave in the market place) –Collusive: act together –Non-collusive: act separately and/or strategicially

19 How do we tell? Market concentration refers to the size and distribution of firm market shares and the number of firms in the market. Economists use two measures of industry concentration: –Four-firm Concentration Ratio –The Herfindahl-Hirschman Index

20 Four-Firm Concentration Ratio The four-firm concentration ratio (CR4) measures market concentration by adding the market shares of the four largest firms in an industry. –If CR4 > 60, then the market is likely to be oligopolistic.

21 Example FirmMarket Share Nike62% New Balance15.5% Asics10% Adidas4.3%

22 The Herfindahl-Hirschman Index The Herfindahl-Hirschman index (HHI) is found by summing the squares of the market shares of all firms in an industry. –Advantages over the CR4 measure: Captures changes in market shares Uses data on all firms

23 Example FirmMarket Share Nike62% New Balance15.5% Asics10% Adidas4.3%

24 Example (cont’d) FirmMarket Share Nike22.95% New Balance22.95% Asics22.95% Adidas22.95% What happens if market shares are evenly distributed?

25 How do they determine whether a merger reduces competition? Herfindahl-Hirschman Index or HHI, –measure of the size of firms in relationship to the industryfirms industry –Meant to be an indicator of the amount of competition –sum of the squares of the market shares of each individual firm. decreases in the Herfindahl index generally indicate a loss of pricing power and an increase in competition, whereas increases imply the opposite DOJ guidelines –Mergers resulting in HHI > 1800 can be challenged

26 Figure Four-Firm Concentration Ratio (CR4) for Selected Industries in 1997

27 Are All Mergers Equal? Conglomerate –Merger of firms in unrelated industries Vertical Merger –Merger of firms upstream/downstream from each other in production stream FCC: ownership of more than 1 media type Microsoft Horizontal Mergers –Firms in the same industry Telecomm industry –AT&T divestiture –Verizon/GTE merger; RBOC mergers Would the HHI be a valid measure of competitiveness?